Self-Fulfilling Runs: Evidence from the U.S. Life Insurance Industry

Abstract

The interaction of worsening fundamentals and strategic complementarities among investors renders identification of self-fulfilling runs challenging. We propose a dynamic model to show how exogenous variation in firms' liability structures can be exploited to obtain variation in the strength of strategic complementarities. Applying this identification strategy to puttable securities offered by U.S. life insurers, we find that 40 percent of the $18 billion run on life insurers by institutional investors during the summer of 2007 was due to self-fulfilling expectations. Our findings suggest that other contemporaneous runs in shadow banking by institutional investors may have had a self-fulfilling component.

The Life Insurance Industry and Systemic Risk: A Bond Market Perspective

“…Koijen and Yogo (2016a) argue that captive reinsurance, a common practice that allows primary insurers to hold less regulatory capital, leads to greater opacity and leverage in the insurance sector and significantly increases the probability of an insurer default. Foley-Fisher, Narajabad and Verani (2015) show certain forms of insurer funding can also be vulnerable to runs. Specifically, they study extendible funding agreement backed notes, a product that involves considerable maturity transformation, and…”

Securities Lending as Wholesale Funding: Evidence from the U.S. Life Insurance Industry

“…In light of these vulnerabilities, measures such as the degree of liquidity transformation in 27 Regulatory arbitrage as a source of reach for yield has already been documented in the U.S. life insurance industry through the deliberate portfolio selection of more risky corporate bonds within a rating class (Becker & Ivashina 2015), the use of captive reinsurers to lower regulatory capital charges (Koijen & Yogo 2016), and the issuance of institutional funding agreements (Foley-Fisher et al 2015).…”

“…6 The experience of securities lenders was repeated throughout the financial system, with runs on repo markets (Gorton & Metrick 2010a,b, 2012, asset-backed commercial paper (Covitz, Liang & Suarez 2013, Schroth, Suarez & Taylor 2014, MMFs (Schmidt, Timmermann & Wermers 2016), and life insurance companies (Foley-Fisher, Narajabad & Verani 2015).…”

Bank's Liquidity Management and Financial Fragility

“…Financial fragility and self-fulfilling runs are not a phenomenon of the past: for example, Argentina in 2001 and Greece in 2015 faced such systemic events. Similarly, many U.S. money market and life insurance funds -that perform liquidity and maturity transformation, and therefore are functionally similar to traditional banks -experienced self-fulfilling runs after the bankruptcy of Lehman Brothers in 2008 (Foley-Fisher et al, 2015). Moreover, there is a wide consensus that a key part of the global financial crisis can be interpreted as a systemic self-fulfilling run of financial intermediaries on other financial intermediaries (Gorton and Metrick, 2012), and that also the EU joint bank and sovereign crisis had a significant self-fulfilling component (Baldwin et al, 2015).…”